January 16, 2025

The Only Number That Matters in Today’s Market

Fourth-quarter earnings season is underway, and while expectations are high at an estimated 11.9% average year-over-year growth among S&P 500 companies, according to data collected by Factset, the actual numbers probably won’t matter much to the market’s short- and intermediate-term direction.

Ignore inflation numbers too. CPI and PPI – this week’s dual reports of the December results – were encouragingly cooler than expected. But in the end, what really matters is how they impact the Fed’s decision-making, which we probably won’t know until at least the end of the month.

Until then, and frankly regardless of what Jerome Powell says later this month and beyond, there’s only one number that will truly determine which way the market goes next: the 10-year Treasury yield. In September, around the time the Fed made its first, deceptively aggressive 50-basis-point rate cut, the yield dipped to 3.6%, and stocks took off. Since then, Treasury yields have been on a steady climb, topping 4.8% this week for the first time in 14 months.

It’s no coincidence that as the 10-year yield has accelerated in the last six weeks as the Fed has become more hawkish that stocks have fallen off, considerably in some cases. On December 6, the 10-year note yielded 4.15%, neatly coinciding with an all-time market top. Since then, yields have ballooned by more than 15%, while the S&P has retreated more than 4% while under-the-surface measurements like the Russell 2000 and the Equal-Weight Index have fallen 11% and 8%, respectively.

This chart, courtesy of Stockcharts.com, demonstrates the inverse relationship between Treasury yields (purple line) and stocks (red line) in the last year:

And the magic number is 4.5%.

When the Treasury yield is below 4.5%, stocks mostly flourish. When it’s above 4.5%, they flounder.

To wit: from the beginning of June through mid-December, the yield was below 4.5% virtually the entire time, and the S&P was up 15%. Last April and May, when the yield was mostly above 4.5%, the S&P was flat; and in the past month, it’s down 2.5%.

Granted, there have been exceptions, like when the market cratered last July and early August when yields were mostly in the 4.1%-4.2% range. But as you can see from the chart above, once rates dipped below 4%, stocks took off again.

So, while the market isn’t immune to pullbacks while Treasury yields are below 4.5%, it’s all but incapable of rallying, at least for more than a few days, when yields are above 4.5%. And that made yesterday’s dip to 4.65% – fueled by the better-than-anticipated CPI print – encouraging. Investors certainly ate it up, with every index, including the Russell, up more than 1.5%. For the rally to last, yields will need to pull in a little more in the coming days.

This has been one of the stranger bull markets in history, with high interest rates limiting investor enthusiasm for most stocks outside the sure bets that comprise the Magnificent Seven or a select few artificial intelligence leaders. It’s why money market funds have risen to a record $7 trillion and the majority of sectors remain undervalued. Eventually, rates will come down, and perhaps more widespread buying will ensue. But for now, the Fed is king, and Treasury yields matter.

If they reverse course and fall back below 4.5% in the coming days, then there’s a good chance the worst of the December/January selloff is behind us.

Note to new subscribers: You can find additional commentary on past earnings reports and other news on recommended companies in prior editions and weekly updates of the Cabot Value Investor on the Cabot website.

Send questions and comments to chris@cabotwealth.com.

Also, please join me and my colleague Brad Simmerman on our weekly investment podcast, Cabot Street Check. You can find it wherever you get your podcasts, or you can watch us on the Cabot Wealth Network YouTube channel.

This Week’s Portfolio Changes
None

Last Week’s Portfolio Changes

New Buy – Peloton (PTON), with a price target of 12

Upcoming Earnings Reports

Tuesday, January 21 – United Airlines (UAL)

Growth & Income Portfolio

Growth & Income Portfolio stocks are generally higher-quality, larger-cap companies that have fallen out of favor. They usually have some combination of attractive earnings growth and an above-average dividend yield. Risk levels tend to be relatively moderate, with reasonable debt levels and modest share valuations.

BYD Company Limited (BYDDY) has long been one of China’s top automakers. What really sent its sales into hyperdrive, however, was when it made the switch to all battery electric and hybrid plug-in vehicles in 2022. Revenues instantly tripled, going from $22.7 billion in 2020 (a record, despite the pandemic) to $63 billion in 2022. In 2023, sales improved another 35%, to $85 billion. In 2024, it’s on track for $106.4 billion, or 25% growth, with another 20% growth expected in 2025. The EV maker has emerged as a legitimate rival to Tesla.

But there’s even greater upside. Right now, BYD does roughly 90% of its business in China, accounting for one-third of the country’s total sales of EVs and hybrids this year. The company is trying to change that, recently opening its full-assembly plant outside of China, with a new plant in Thailand starting deliveries. A plant in Uzbekistan puts together partially assembled vehicles. A plant in Brazil is expected to open early next year. And BYD has plans to open more new plants in Cambodia, Hungary, Indonesia, Pakistan and Turkey. Mexico and Vietnam are possible targets as well. Despite no plans to do business in America just yet, BYD is on the verge of becoming a global brand.

And while BYDDY stock has fared well, it hasn’t grown as fast as the company. At 15.3x earnings estimates, BYDDY currently trades at less than 20% of its five-year average forward P/E ratio (89.6). And its price-to-sales (1.03) ratio is about half the normal five-year ratio. As BYD continues to expand globally, look for its valuation to catch up with its industry-leading performance.

The Chinese electric vehicle giant sold 207,734 EVs in December, pushing its 2024 total to 1.76 million battery-electric vehicles sold. Total vehicle sales improved 41% for the year, though the biggest jump came in the company’s hybrid models. While fourth-quarter results aren’t due out until March, its sales outpaced Tesla’s for the first time in the third quarter. To me, buying BYD now has the potential to be like buying TSLA shares 10 years ago.

Despite the strong December sales numbers, BYDDY shares are down since the data was released earlier this month, though they did bounce back this week, up 1.7% on no company-specific news. Perhaps the nonsensical mini-selloff is over. The stock has 35% upside to our 90 price target, which may prove to be conservative. BUY

The Cheesecake Factory Inc. (CAKE) is ubiquitous. With 345 North American locations, chances are you’ve eaten at one, indulged in their specialty high-calorie but oh-so-tasty cheesecakes and browsed through menus long enough to be a James Joyce novel. But despite being seemingly everywhere already and nearly a half-century old, the company is still growing.

Sales have improved every year since Covid (2020), reaching a record $3.44 billion in 2023. In 2024, revenues are on track for $3.57 billion. But the earnings growth is the real selling point. EPS more than doubled in 2023 (to $2.10 from 87 cents in 2022) and are estimated to swell to $3.31 in 2024, a 57.6% improvement, and to $3.69 next year.

It’s still expanding too, opening 17 new restaurants through the first three quarters of 2024. It expects to open a total of 22 new restaurants by year’s end. Those aren’t just Cheesecake Factories – the company also owns North Italia, a handmade pizza and pasta chain; Flower Child, a health food chain that caters to those with special diets (vegetarians, vegans, gluten-free, etc.); and Blanco, a Mexican chain owned by Fox Restaurant Concepts, which The Cheesecake Factory Corp. acquired in 2019.

Despite some recent strength in the stock, CAKE shares trade at 13.4x 2025 EPS estimates and at 0.68x sales. The bottom-line valuation is well below the five-year average forward P/E ratio of 15.6; the price-to-sales ratio is in line with the five-year average.

With shares trading at roughly 25% below their 2017 and 2021 highs, there’s plenty of room to run.

There was no company-specific news for Cheesecake Factory this week, and shares mostly held their ground after advancing 2% the previous week.

The last bit of company-specific news came in late October when the company reported Q3 earnings, which were solid. Sales improved by 4.2% while diluted EPS expanded by 65%. Same-store sales increased 1.6%. The strong quarter got Wall Street’s attention: six major firms have either upgraded their price target or initiated coverage on CAKE since the report.

CAKE shares have 32% upside to our 65 price target. The 2.2% dividend yield adds to the appeal. BUY

Dick’s Sporting Goods (DKS) has been growing steadily for years.

From 2016 to 2023, the sporting goods chain’s revenues have improved 64%, from just under $8 billion to just under $13 billion. In 2024, the top line is on track to top $13 billion for the first time. It should top $13.5 billion in 2025.

Dick’s, in fact, has grown sales in each of the last seven years – including in 2020 and 2021, when most other retailers saw sales nosedive due to Covid restrictions. But Dick’s all-weather ability to keep growing no matter what’s happening in the world or the economy speaks to its versatility. Since Covid ended, however, Dick’s sales have entered another stratosphere. As youth sports returned in 2021, Dick’s revenues jumped from $9.58 billion to $12.29 billion. They’ve been rising steadily each year since and are expected to do so again this year.

But Dick’s isn’t purely a growth stock—it’s also undervalued. DKS shares currently trade at just less than 15x forward earnings estimates and at 1.36x sales. To be sure, it’s not the cheapest stock in our portfolio. But it is one of the fastest growing – and pays a solid dividend to boot.

There was no company-specific news for Dick’s this week, though shares did give back the 1% they’d gained the previous week, as the 235 level is still acting as overhead resistance.

The stock has been on an upward trajectory since reporting earnings in November. It was yet another solid quarter for the sporting apparel giant. Both sales and earnings topped estimates and, perhaps more importantly, the company raised full-year same-store sales growth guidance to a range of 3.6% to 4.2%, up from the previous range of 2.5% to 3.5%. Earnings per share improved 15% year over year, while sales ticked up only slightly. The company credited a robust back-to-school shopping season for its strength in the third quarter. Also, Dick’s is expanding its new House of Sport concept – 100,000-square-foot arenas that feature rock climbing walls and running tracks. It expects to open 15 new ones next year and is aiming for a range of 75 to 100 nationwide by 2027.

DKS shares are up 7% since the earnings report. They have 10% upside to our 250 price target. BUY

Toll Brothers (TOL) – Historically, when the Fed cuts interest rates, homebuilder stocks are among the first to benefit. Indeed, in 2019 and early 2020 (before Covid hit), during which the Fed cut rates from 2.5% to 1.5%, homebuilder stocks were up 64%, more than double the 30% bump in the S&P 500. Now, with the Fed finally cutting rates for the first time in four and a half years, the homebuilders are undervalued, trading at 13x forward earnings. Toll Brothers is even cheaper, trading at 9x estimates – and growing faster than the average bear. In fiscal 2024, revenue improved 10% year over year while adjusted EPS was up 12.7%, which compared favorably to 2023 results (13.6% EPS growth on a 2.7% downturn in revenues).

Toll Brothers isn’t the biggest homebuilder in the U.S. – its $10.5 billion in revenue last year paled in comparison to the likes of D.R. Horton’s ($35 billion), PulteGroup’s ($16 billion), or Berkshire Hathaway holding Lennar’s ($34 billion). But it’s cheaper and growing faster than all of them.

TOL shares had their best week in months, rising 6.5% as bond yields finally pulled back after touching 14-month highs above 4.8% the previous week. The 30-year mortgage rate hasn’t come down a bit, though, at 6.9%. There was no company-specific news.

Still, the cooler inflation reports this week were good news for Toll Brothers and other homebuilders, as it quieted talk of fewer Fed rate cuts this year and has taken the extreme view that the Fed might actually hike rates by year’s end off the table, for now.

So, let’s continue to play the long game with TOL. TOL shares have 34% upside to our 180 price target. At 9x forward earnings, shares are incredibly cheap. BUY

United Airlines (UAL) – People are flying in planes again in Covid’s aftermath, and no major airline is taking advantage of it quite like United.

United Airlines is the fastest-growing major U.S. airline. The third-largest airline carrier in the world by revenues behind Delta (DAL) and American (AAL), United is expected to grow sales by 5.9% in 2024 – more than its two larger competitors – and that’s with revenues already topping a record $50 billion in 2023 – 19.6% higher than in 2022, which was also a record year. For United, business has not only returned to pre-pandemic levels; it’s better.

Meanwhile, the stock is super cheap. It trades at a scant 7.7x forward earnings estimates, with a price-to-sales ratio of just 0.58.

A company that’s making more money than ever before (gross profits reached a record $15.2 billion in 2023, though earnings were still second to 2019 levels on a per-share basis), and yet its stock trades at barely more than half its peak from five and a half years ago. A true growth-at-value-prices opportunity.

The good times keep rolling for UAL, as shares were up another 5% this week to reach new all-time highs above 107! Perhaps next Tuesday’s (January 21) earnings are already being priced in. Analysts are looking for 50% EPS growth on 5.2% sales growth, and the company has beaten EPS estimates in each of the last four quarters. It’s possible the estimates are conservative again.

We sold half our shares in November and are letting the rest ride but are maintaining a Hold rating. Any real turbulence will likely prompt us to bail on this big winner before our remaining profits erode much. For now, though, the stock is still very much in favor, and shares have more than doubled since we added it to the portfolio last May. HOLD HALF

Buy Low Opportunities Portfolio

Buy Low Opportunities Portfolio stocks include a wide range of value opportunities. These stocks carry higher risk than our Growth & Income stocks yet also offer more potential upside. This group may include stocks across the quality and market cap spectrum, including those with relatively high levels of debt and a less clear earnings outlook. The stocks may not pay a dividend. In all cases, the shares will trade at meaningful discounts to our estimate of fair value.

ADT Inc. (ADT) is literally a household name.

It’s a 150-year-old home security company whose octagon-shaped blue signs with white lettering that say “Secured by ADT” are ever-present in neighborhoods across the country. ADT provides security to millions of American homes and businesses, with products ranging from security cameras, alarms and smoke & CO detectors, to door/window/glass break sensors and more, all of which can alert one of ADT’s industry-best six 24/7 monitoring centers if any one of those security systems is breached.

Business has been fairly stable, with annual revenues hovering in the $5 billion range for four of the last five years (2021 was an exception, with a dip down to $4.2 billion during Covid) and is on track to do it again both this year and next. But where the century-and-a-half-old company has really improved of late is profitability. The last two years marked the first time the company has been in the black in consecutive years, with earnings per share going from 15 cents in 2022 to 51 cents in 2023; in 2024, EPS is expected to improve another 43%, to 73 cents, and then to 83 cents (+14%) in 2025.

All of that EPS growth makes the share price look quite cheap. ADT shares currently trade at just 9x earnings estimates and at just 1.2x sales. A solid dividend (3.1%) adds to the appeal of this mid-cap stock.

There’s been no company-specific news for ADT of late, and shares have stabilized the last couple weeks after selling off for most of December. The stock is up 2.5% this week to finally get some separation from its early-January bottom below 7.

There’s been no real news since late October, ADT reported earnings that beat on both the top and bottom lines. Adjusted EPS of 20 cents topped 17-cent estimates, while revenues ($1.24 billion) narrowly edged estimates ($1.22 billion) and marked a 5% year-over-year improvement. EBITDA ($659 million) also came in slightly higher than expectations. Meanwhile, the company maintained its full-year revenue guidance of $4.9 billion and raised EPS guidance to 73 cents at the midpoint – a 3.6% increase. Its recurring monthly revenue reached $359 million, a new record.

The numbers weren’t jaw-dropping, but there was a lot to like in the report, and investors quickly snatched up ADT shares accordingly – they were trading below 7 prior to the report. They eventually sagged back to pre-earnings levels but are now gaining steam again. But the stock remains cheap, trading at 9x forward earnings. The shares have 39% upside to our 10 price target. BUY

Aviva, plc (AVVIY), based in London, is a major European company specializing in life insurance, savings and investment management products. Amanda Blanc, hired as CEO in July 2020, is revitalizing Aviva’s core U.K., Ireland and Canada operations following her divestiture of other global businesses. The company now has excess capital which it is returning to shareholders as likely hefty dividends following a sizeable share repurchase program. While activist investor Cevian Capital has closed out its previous 5.2% stake, highly regarded value investor Dodge & Cox now holds a 5.0% stake, providing a valuable imprimatur as well as ongoing pressure on the company to maintain shareholder-friendly actions.

Aviva has finalized its agreement to buy Direct Line Insurance Group for 3.7 billion pounds ($4.65 billion), creating the largest motor insurance company in the United Kingdom. The deal is expected to be completed by mid-2025. AVVIY shares are down more than 7% since its Direct Line takeover bid was first reported on November 27 – which is normal share price action for the acquiring company. But shares should eventually bounce back, as the Direct Line addition should give this U.K.-based insurance and investment management firm a market cap of $21.2 billion, up from its current $15.4 billion. That gives AVVIY shares 37% upside from their current price. The 7.6% dividend yield should tide us over until shares get going again. BUY

The Cigna Group (CI) is the fifth-largest healthcare company in the U.S., with $229 billion in revenue over the last 12 months. It’s a health benefits and medical care provider with a market cap of $82 billion, 170 million customers in over 30 countries, that pays a dividend (2% yield) and is on track to grow sales by 25% and earnings by 13.5% this year and another 10.8% next year. And yet, the stock hasn’t budged much in two years and trades at a mere 8.9x earnings estimates and 0.35x sales. It’s the cheapest CI shares have been in more than a year.

Why the underperformance? Earnings have been inconsistent, with EPS declining 18.8% in 2023 and by 31.4% in 2021. But that appears to be changing, with double-digit growth expected both this year and next, led by its Evernorth Health Services branch, which reported 36% revenue growth in the latest quarter. And healthcare stocks as a group were the second-worst performer of the 11 major S&P 500 sectors in 2024, up a mere 0.87%. As Baby Boomers reach their golden years, healthcare is more in demand than ever, so the sector won’t stay down long. And CI has a habit of outperforming when times are good.

Cigna shares have been in slow recovery mode, rising roughly 1.5% in each of the past two weeks despite news yesterday that it – along with UnitedHealth and CVS – was one of the biggest big pharma abusers of using so-called “middlemen” to peddle their drugs, for large fees, resulting in a combined $7.3 billion in excess revenue over a six-year period. It’s a bad look and puts Cigna under a microscope with the Federal Trade Commission (FTC) and President-elect Donald Trump when he takes office next week. But, the news relates to something that’s already happened and probably won’t impact Cigna’s future earnings or revenue much, which is why the stock hasn’t been impacted.

We downgraded CI to Hold a few weeks after it got off to a rough start due to factors that had very little to do with the company specifically. Let’s keep it at Hold until we see more momentum in the share price. HOLD

Peloton (PTON) was all the rage during Covid, as people stuck at home snatched up the stationary bike with a built-in, interactive touch screen like hotcakes, and revenues quadrupled in two years. Then, Covid ended, people stopped buying Pelotons, and PTON shares – up 700% in the last nine months of 700% – fell to nearly zero, at a scant $3 per share. The selling was overdone, considering Pelton’s sales only fell off by about a third. Now, the bleeding has just about stopped, and the company is expecting to grow again in the coming year. Aggressive cost-cutting – the company is lowering costs by $200 million this (2025) fiscal year alone – has narrowed profit losses and allowed Peloton to generate free cash flow again. It’s using that cash to attract and retain customers, investing in software updates such as personalized workout plans and private “teams” for every subscriber. It’s offering new apps such as Strength+ and fitness “games.” And it is exploring new strategic partnerships to broaden its reach and perhaps start attracting new customers again.

Meanwhile, the company just underwent a regime change – always an appealing catalyst for turnaround candidates. Former Ford executive Peter Stern has taken over as CEO, assuming the helm from embattled former CEO Barry McCarthy after two mostly unsuccessful years on the job.

Add it all up, and suddenly there are a lot of potential catalysts for Peloton for the first time since the pandemic. And the stock has become grossly oversold, currently trading at 1.17x sales, about a quarter of its five-year average and galaxies below the 20x P/S ratio from late 2020 and even the 6.9x sales shares were going for in late 2021.

There was no news for Peloton in its first week in the Cabot Value Investor portfolio, but shares were up 2.5%, most of which came during Wednesday’s market rally.

After falling below 3 per share in August, PTON shares have tripled. And yet, shares remain cheap on a price-to-sales basis, and sales are no longer cratering the way they were in 2022-23 and are actually expected to start expanding again in the next (2026) fiscal year, which begins in July.

Earnings are due out in a few weeks so those will likely determine if the stock can keep up its recent momentum. Shares have 34% upside to our 12 price target. BUY

Note for stock table: For stocks rated Sell, the current price is the sell date price.

Current price is yesterday’s mid-day price.

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